THE European Commission has dealt a blow to a central plank of Joan Burton's campaign to become Labour Party leader by insisting the Government must inflict another €2bn of austerity.

In its annual report on the Irish economy, the Commission described the Government's budget forecasts as "optimistic" and said that more tax hikes and spending cuts would be needed in October's Budget.

But Ms Burton – who is vying to become Tanaiste and rebuild her party – last night told the Irish Independent that a €2bn adjustment would "neither be necessary – nor desirable".

The Commission is withering when it comes to the Government's economic forecasts, saying the present medium-term review is vague.

Brussels believes Finance Minister Michael Noonan will fail to cut the deficit to the agreed levels next year.

The report says:

* Not enough people are paying property tax.

* The Government should increase VAT.

* Cheap childcare is needed to get women back to work.

* Tax on workers is fragmented and complex.

* More training must address a skill mismatch among young people.

* Spending on medicines is too high.

Despite the sharp warning from Europe, a spokesman for Social Protection Minister Burton said that "an adjustment of that scale now would serve only to hinder the recovery".

Her stance puts her at loggerheads with the European Commission and Fine Gael as Mr Noonan is on the record as saying that he will have "little discretion" in the Budget.

While Ms Burton currently plays little role in economic decision making, she is almost certain to join the influential Economic Management Council if elected Labour leader.

The report on the situation here was one of 26 bulletins on EU member states published yesterday.

Other countries such as France and Italy were also urged to stick to their pledges to curb spending while reforming their economies.

The Commission urged the Government to extend the property tax to more homes and increase VAT, which is already higher than almost all other countries in the world outside Scandinavia.

Many home owners don't pay the tax at present, including those who buy from a builder or developer before October 2016.

Houses owned by residential charities and sheltered accommodation for the elderly or the disabled are also excluded along with mobile homes, houses belonging to diplomats and houses certified as having significant pyritic damage.

Welfare

“Property taxation has been shifted away from a transaction tax to a recurrent tax based on residential property values but the tax is still relatively narrow as certain properties remain outside of the tax net,” the Commission complains.

When it comes to VAT, the Commission says it is a blunt instrument and reductions help the wealthy along with the poor, adding that welfare is a better method of helping people.

Europe also calls on the Government to simplify, but not reduce, the “fragmented and complex” list of taxes such as the universal social charge and PRSI which eat into our take-home pay.

The taxation system is one of the many things that come in for criticism in the annual report on the economy – a feature for all European Union members since the adoption of the Lisbon Treaty.

The report is highly critical of the Government's “optimistic” assumptions about growth after next year.

It also criticises schemes for the long-term unemployed and welfare traps that stop the unemployed, especially single mothers, from returning to work.

Government rules which remove medical cards from those returning to work along with rent allowance are among the traps mentioned.

Expensive childcare has also been singled out as one of the reasons why just 67pc of women have jobs compared to 83pc of men.

Relatively low levels of training later in life, lack of apprenticeships and employment support schemes also come in for criticism.

Other criticisms include the cost of legal services and lack of competition among lawyers, the failure to enact the Legal Services Regulation Bill, on the books since 2011 and weak bank lending to companies.

The Commission also wants the Government to monitor banks' performance on mortgage arrears to ensure borrowings are restructured.